Depreciation is the amount you can deduct annually to recover the cost (or other basis) of business property with a useful life of more than 1 year. You can depreciate tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. You can also depreciate the cost of improvements to tangible property if the improvement:
Adds to the value of the property;
Appreciably lengthens the time the property can be used; or
Adapts the property to a different use.
However, the cost of repairs to keep the property in a normal efficient operating condition must be deducted rather than depreciated.
You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most of the property that you place in service after 1986. Under MACRS, 3 conventions are used to determine when property is considered to be placed in service:
Half-year convention. In most cases, the half-year convention is used for personal property. Personal property includes machinery, furniture, and equipment. Under the half-year convention, a half-year of depreciation is allowed in the first year of depreciation, regardless of when during the year you placed the asset in service.
Mid-quarter convention. If more than 40% of the assets placed in service during the year were placed in service in the last 3 months of the year, the mid-quarter convention must be used instead of the half-year convention. Under the mid-quarter convention, property is considered placed in service at the midpoint of a quarter regardless of when it was placed in service during the quarter.
Mid-month convention. Real property, such as buildings, is depreciated under the mid-month convention and is considered placed in service at the midpoint of the month regardless of the actual date it was placed in service.
Example: Tina Minor, a ceramist, placed a potter’s wheel for which she paid $1,200 in service in January. She also placed a kiln for which she paid $3,300 in service in November. Because the cost of the kiln exceeds 40% of the total cost of property placed into service during the year, Tina must use the mid-quarter convention.
Under Section 179, you can claim a deduction in the current year by deducting all or a portion of the cost of certain property instead of depreciating it. For 2010, the Section 179 deduction allows you to write-off up to $125,000 of the cost of qualified property. Limitations apply if you place more than $500,000 of Section 179 property into service during the year.
Property that is eligible for the Section 179 deduction includes:
Tangible personal property such as machinery, equipment, automobiles, and computers
Certain research and storage facilities
Single-purpose agricultural structures
Off-the-shelf computer software placed in service after 2002 and before 2011
Businesses located in enterprise zones, renewal communities, or the New York Liberty Zone may be eligible for an increased depreciation deduction. Certain property with a long production period, qualified Liberty Zone property, and qualified GO Zone property also qualifies for a special depreciation allowance.
Special depreciation rules apply to listed property. Listed property includes:
Passenger automobiles and other property used for transportation, but excludes vehicles that are not likely to be used for personal purposes due to their nature or design, such as emergency vehicles, large trucks and buses, and other special duty vehicles.
Property generally used for entertainment, recreation, or amusement that isn’t used exclusively at a regular place of business. This includes photographic, communication, and video recording equipment.
Computers not used exclusively at a regular place of business.
Cellular telephones.
Listed property must be used more than 50% of the time for business purposes. If you use the property less than 50% of time for business in the year placed in service, you can’t take a Section 179 deduction. Instead, you must depreciate the property using the alternative depreciation system (ADS). Under ADS, the straight-line method is used.
To learn more, see IRS Publication 946, How to Depreciate Property.